Chapter 13, Problem 14P

1. a.

To determine

Prepare the journal entries to record the investment in shares transactions, using fair value method, and classify the securities as available-for-sale securities.

Explanation of Solution

Investment: It refers to the process of using the currently held excess cash to earn profitable returns in future. The investments can be made in equity securities such as shares or debt securities such as bonds.

Available for sale securities: these are the securities which are not intended to be sold in the near future and there is no intension to hold the securities till their maturity.

Prepare the journal entries to record the investment in shares transactions, using fair value method, and classify the securities as available-for-sale securities.

Record the purchase of Company G’s shares on January 1, 2015.

Step 1: Determine the number of shares purchased.

$\begin{array}{c}\text{Number of shares purchased=}\left[\begin{array}{l}\text{Company G's outstanding shares}\times \text{Percentage}\\ \text{of Company G's shares acquired by Corporation S}\end{array}\right]\\ =200,000\text{shares}\times 20\%\\ =40,000\text{shares}\end{array}$

Corporation S purchased 20% shares of Company G for $\left(40,000\text{shares}\times \$4\text{per share}\right)$ $160,000.

Step 2: Record the entry.

Date	Account Title and Explanation	Debit	Credit
January 1, 2015	Investment in Available-for-sale Securities	$160,000
	Cash		$160,000
	(To record the purchase of 20% shares of Company G)

Table (1)

Record the dividend income received on December 31, 2015.

Corporation S received $\left(\text{\$30,000 dividend declared by Company G×20\%shares held}\right)$ $6,000 dividend.

Date	Account Title and Explanation	Debit	Credit
December 31, 2015	Cash	$6,000
	Dividend income		$6,000
	(To record the amount of dividend income received from investment)

Table (2)

Record the unrealized gain or loss on available-for-sale securities, as on December 31, 2015.

Step 1: Determine the amount of unrealized holding loss or gain.

$\begin{array}{c}\begin{array}{l}\text{Unrealized holding}\\ \text{loss or gain}\end{array}\}\text{ =}\left[\begin{array}{l}\text{Number of shares purchased}\times \\ \left(\begin{array}{l}\text{Market value per share on December 31, 2015}\\ -\text{Purchase price per share}\end{array}\right)\end{array}\right]\\ =\left[40,000\text{shares}\times \left(\$3.80-\$4.00\right)\right]\\ =-\$8,000\left(\text{loss}\right)\end{array}$

Step 2: Record the adjusting entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2015	Unrealized holding gain or loss: Available-for-sale securities	$8,000
	Allowance for change in fair value of         investment		$8,000
	(To record the unrealized holding loss on investment)

Table (3)

Record the dividend income received on December 31, 2016.

Corporation S received $\left(\text{\$35,000 dividend declared by Company G×20\%shares held}\right)$ $7,000 dividend.

Date	Account Title and Explanation	Debit	Credit
December 31, 2016	Cash	$7,000
	Dividend income		$7,000
	(To record the amount of dividend income received from investment)

Table (4)

Record the unrealized gain or loss on available-for-sale securities, as on December 31, 2016.

Step 1: Determine the amount of unrealized holding loss or gain.

$\begin{array}{c}\begin{array}{l}\text{Unrealized holding}\\ \text{loss or gain}\end{array}\}\text{ =}\left[\begin{array}{l}\text{Number of shares purchased}\times \\ \left(\begin{array}{l}\text{Market value per share on December 31, 2015}\\ -\text{Purchase price per share}\end{array}\right)\end{array}\right]\\ =\left[40,000\text{shares}\times \left(\$4.25-\$4.00\right)\right]\\ =\$10,000\left(\text{gain}\right)\end{array}$

Step 2: Determine the amount of allowance to be adjusted to have $10,000 debit balance in allowance account at the end of the year 2016, using T-account.

Credit balance in allowance account on December 31, 2015 is $8,000.

Table (5)

Step 3: Record the adjusting entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2016	Allowance for change in fair value of investment	$18,000
	Unrealized holding gain or loss:         Available-for-sale securities		$18,000
	(To adjust the unrealized holding gain on investment)

Table (6)

Note:

Under the fair value method of recording the investment, no entry is required for recording the investee company’s net income.

1. b.

To determine

Prepare the journal entries to record the investment in shares transactions, using equity method.

Explanation of Solution

Record the purchase of Company G’s 20% outstanding common stock:

Date	Account Title and Explanation	Debit	Credit
January 1, 2015	Investment in Stock: Company G	$160,000
	Cash		$160,000
	(To record the purchase of 20% shares of Company G)

Table (7)

Record the income from investment.

Step 1: Determine the amount of investment income.

$\begin{array}{c}\text{Investment income= }\left[\begin{array}{l}\text{Net income of the year 2015 reported by Company G}\times \\ \text{Percentage of Company G}\text{'}\text{s common stocks}\\ \text{acquired by Corporation S}\end{array}\right]\\ =\$80,000\times 20\%\\ =\$16,000\end{array}$

Step 2: Record the entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2015	Investment in Stock: Company G	$16,000
	Investment income		$16,000
	(To record the income earned from investment)

Table (8)

Record the receipt of dividend.

Step 1: Determine the amount of cash received as dividend.

$\begin{array}{c}\text{Cash = }\left[\begin{array}{l}\text{Amount of dividend declared by Company G}\times \\ \text{Percentage of Company G}\text{'}\text{s common stocks}\\ \text{acquired by Corporation S}\end{array}\right]\\ =\$30,000\times 20\%\\ =\$6,000\end{array}$

Step 2: Record the entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2015	Cash	$6,000
	Investment in Stock: Company G		$6,000
	(To record the receipt of cash dividend)

Table (9)

Record the income from investment.

Step 1: Determine the amount of investment income.

$\begin{array}{c}\text{Investment income= }\left[\begin{array}{l}\text{Net income of the year 2016 reported by Company G}\times \\ \text{Percentage of Company G}\text{'}\text{s common stocks}\\ \text{acquired by Corporation S}\end{array}\right]\\ =\$90,000\times 20\%\\ =\$18,000\end{array}$

Step 2: Record the entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2016	Investment in Stock: Company G	$18,000
	Investment income		$18,000
	(To record the income earned from investment)

Table (10)

Record the receipt of dividend.

Step 1: Determine the amount of cash received as dividend.

$\begin{array}{c}\text{Cash = }\left[\begin{array}{l}\text{Amount of dividend declared by Company G}\times \\ \text{Percentage of Company G}\text{'}\text{s common stocks}\\ \text{acquired by Corporation S}\end{array}\right]\\ =\$35,000\times 20\%\\ =\$7,000\end{array}$

Step 2: Record the entry.

Date	Account Title and Explanation	Debit	Credit
December 31, 2016	Cash	$7,000
	Investment in Stock: Company G		$7,000
	(To record the receipt of cash dividend)

Table (11)

Note: Under the equity method of recording the investment, no entry is required for recording the increase in the investee company’s market value.

2. a.

To determine

Prepare the journal entries to record the sale of 10,000 of Company G’s shares, using fair value method, and classify the securities as available-for-sale securities.

Explanation of Solution

Record the sale of 10,000 shares of Company G for $4.25 per share on January 4, 2017, under fair value method.

Corporation S sold Company G’s shares and received cash of $42,500$\left(10,000\text{shares }\times \text{\$4}\text{.25per shares}\right)$.

Determine the cost of investment in available-for-sale securities sold on January 4, 2017.

$\begin{array}{c}\begin{array}{l}\text{Cost of investment in}\\ \text{available-for-sale securities}\\ \text{sold on January 4, 2017}\end{array}\}\text{ =}\left[\begin{array}{l}\frac{\text{Number of shares sold}}{\text{Number of shares}\text{purchased in 2015}}\times \\ \text{Total purchase price}\end{array}\right]\\ =\left[\frac{10,000\text{shares}}{40,000\text{shares}}\times \$160,000\right]\\ =\$40,000\end{array}$

Record the entry.

Date	Account Title and Explanation	Debit	Credit
January 4, 2017	Cash	$42,500
	Investment in Available-for-sale          Securities		$40,000
	Gain on sale of Available-for-sale           Securities		$2,500
	(To record the gain on sale of available-for-sale of securities)

Table (12)

On January 4, 2017, reverse the unrealized gain that had accumulated at the end of December 31, 2016 for 10,000 numbers of shares sold.

The previously recorded $10,000 unrealized gain and allowance for 40,000 shares should be reversed as follows for 10,000 shares sold $\left[\frac{10,000\text{shares}}{40,000\text{shares}}\times \$160,000\right]\text{= \$40,000}$:

Date	Account Title and Explanation	Debit	Credit
January 4, 2017	Unrealized holding gain or loss: Available-for-sale securities	$2,500
	Allowance for change in fair value of          investment		$2,500
	(To reverse the allowance and  the unrealized gain on holding the Securities of 10,000 shares)

Table (13)

2. b.

To determine

Prepare the journal entries to record the sale of 10,000 of Company G’s shares, using equity method.

Explanation of Solution

Record the sale of 10,000 shares of Company G for $4.25 per share on January 4, 2017, under equity method.

Determine the balance in Corporation S’s investment account on January 4, 2017.

Table (14)

Record the realized gain or loss from sale of 10,000 shares of Company G.

Date	Account Title and Explanation	Debit	Credit
January 4, 2017	Cash	$42,500
	Loss on sale of equity investment	$2,750
	Investment in Stock: Company G		$45,250
	(To record the loss on sale of investment)

Table (15)